In Q3 2021, commission-free trading platform Robinhood Markets (HOOD 3.55%) reported a net loss of $1.32 billion, or $2.06 diluted earnings per share, on net revenue of $365 million, widely missing estimates from analysts. Furthermore, management is guiding for revenue to be less than $325 million in Q4, implying that revenue will come in smaller than any other quarter this year and only be slightly above revenue in Q4 2020. The underwhelming report results in big declines for the stock.
While I do see tremendous potential for Robinhood long-term if management can execute its road map, I ultimately see the stock as a show-me story, meaning that I wouldn't recommend buying shares until there is further proof of execution. Here's why.
A discouraging quarter
Robinhood became a household name by pioneering commission-free trading. Robinhood takes all of the stock orders from its customers and sends them to market makers to carry out the trades, using a system referred to as payment for order flow. Robinhood also does this for options trading and allows customers to purchase certain cryptocurrencies as well. In exchange for its services, Robinhood collects transaction-based revenue for drumming up the business, which is how Robinhood earns the majority of its revenue.
Of this transaction-based revenue, the bulk is from options trading and cryptocurrencies, which is interesting because the bulk of Robinhood's assets under custody (AUC) are actually from equities or traditional stock holdings. That suggests the company is reliant on a select part of its AUC for most of its revenue. Robinhood saw its revenue decline in Q3, largely because of the decline in crypto transactions. Crypto-related revenue fell from $288 million in Q2 to $51 million in Q3. It's easy to see why investors got discouraged with Q3 earnings results.
Management acknowledged on its recent Q3 earnings call that a lot of volume in Q2 had to do with customers purchasing the meme-inspired cryptocurrency Dogecoin (DOGE 2.02%). Seeing crypto revenue surge due to meme trading on Dogecoin is unlikely to get investors excited because it's not consistent.
Other areas Robinhood struggled in Q3 were with net funded accounts, which dipped slightly from Q2, and monthly active users, which were also down. Assets held in Robinhood accounts also fell from $102 billion in Q2 to $95 billion at the end of Q3, led by a dip in equities.
The long-term vision
Management does seem to recognize some of the issues with its current model, which is why it has big plans to expand product offerings and invest heavily back into the company. Operating expenses jumped from $500 million in Q2 to $1.7 billion in Q3.
One big area of expansion is in regards to crypto. Currently, Robinhood only offers seven cryptocurrencies for purchase, and there are currently more than 6,500 in existence. The company would eventually like to offer more cryptocurrencies for sale, and management says it is also seeing a lot of interest from users who want to be able to earn interest on their existing crypto assets. The company plans to roll out a crypto wallet for holding tokens soon; there is already a 1-million-person waitlist for crypto wallets.
CEO Vlad Tenev also said the company is working to roll out more educational content and support for investors, many of whom joined Robinhood as beginner investors. Robinhood recently rolled out 24/7 phone support for customers. There has been growing talk among regulators and lawmakers that platforms like Robinhood with payment for order flow promote investors to make risky investment bets that end up losing money. With increasing regulatory scrutiny, it is certainly in Robinhood's best interest to educate its customer base of new investors. It's also a smart business decision because if Robinhood can turn its customers from beginner to intermediate and expert investors, the company will likely be able to capture more of customers' wallets and see increased average account balances, which currently pale in comparison to other brokerages.
Tenev also talked about capabilities the company is building to enable investors to more easily and electronically transfer investments they have at other brokerages over to Robinhood. Tenev said the company had this capability several years ago, and it experienced more customers transferring their investments inbound to Robinhood than outbound. This then paves the way for customers to move and store their individual retirement accounts on Robinhood, which could be a big opportunity because these are likely larger sums of money that are more stable over time.
I do think Robinhood has an intriguing vision. I also think that people underplay just how good the user interface is. I personally have two brokerage accounts -- one on Robinhood and one on Fidelity -- and I'll use Robinhood every time for buying stocks or options if I can. Getting people onto a platform can sometimes be half the battle, and I think Robinhood has certainly succeeded on this front.
But right now, the company's vision has a lot of execution risk. The regulatory landscape is very uncertain for payment for order flow and crypto. And while I would hope that Robinhood's educational efforts get more people to the platform and increase the average account balance, I need to see some proof of this working first. Until then, I will likely sit on the sidelines for this stock unless shares dip to a more attractive entry point.